On the spectrum of life's great moments, getting a raise is, well, pretty great. After all, it's a quantifiable token of a job well done. Sure, a hearty pat on the back and an earnest "Good job!" from the boss means something. But niceties don't compound with interest.
If you find yourself on the receiving end of a raise, take a moment to weigh your options. Do the math and determine how much money you'll see after taxes. If it's enough to make even a modest impact on the monthly budget, here are just three ideas of what you could do with your extra spending money.
"Most financial professionals would tell you that before you do anything, you should make sure you have enough money saved to cover at least three to six months of expenses," says Doug Ewing, a Certified Financial Planner® and a director of Transamerica’s Advanced Markets group. This provides a cushion in the event of unexpected medical costs, a job loss, or a significant home or car repair. Just make sure the money is accessible without incurring early withdrawal penalties.
If you've got any lingering high-interest debt - like credit cards - there's no time like the present to get rid of it. As for a mortgage, this doesn't necessarily need to be paid down right away. For example, if you're aggressively trying to pay off your mortgage and you suddenly lose your job, you've got a lot of money locked up in the house, Ewing says. You might be better off taking that extra money and putting it into savings.
With some extra income headed your way, now may be the time to max out your workplace retirement contributions. Familiarize yourself with annual contribution limits. In 2017, if you're under 50, it's $18,000 annually. And if you're 50 or over, you can contribute an additional $6,000 for a total of $24,000. You also can consider a traditional 401(k) or Roth 401(k). Ewing likes both options, but notes there might be possible advantages with the Roth.
He uses this example: If you put $100 into a traditional 401(k), you can save money now because it's a pre-tax contribution - and, of course, you'll pay that tax later. To contribute $100 to a Roth 401(k), it's going to cost you about $125 right now in take-home pay due to taxes, but any growth on those dollars would be potentially tax-free at withdrawal.
For younger investors, who might not be in a higher tax bracket yet, the Roth option can make a lot of sense. He says older savers often have most of their contributions in a traditional 401(k), which obviously carries a significant tax burden in retirement.
So it's wise to defer some contributions to a Roth to increase tax diversification in retirement.
For a well-rounded retirement strategy, Ewing likes to think about three sources of money. First is traditional savings. Second is a traditional 401(K) or IRA – where withdrawals will be fully taxable. Third would be a Roth 401(k) or IRA - which would potentially offer tax-free withdrawals.
Ewing acknowledges that you might want to set aside a bit of the raise to treat yourself. Even he splurged on a new set of golf clubs recently. For the record, the last time he bought golf clubs was 17 years ago. So there's that.
How about you? If you get a raise at work, how likely are you to follow these guidelines? Does the splurge get moved up the list of priorities?
Neither Transamerica nor its agents and representatives may provide tax or legal advice. Anyone to whom this material is promoted, marketed, or recommended should consult with and rely on their own independent tax and legal advisors regarding their particular situation and the concepts presented herein.
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